Who qualifies?

The new tax law's 20 percent deduction on qualified business income is subject to limitations that keep it from being a free-for-all for every entrepreneur.

In general, to qualify for the full deduction, your taxable income must be below $157,500 if you're single or $315,000 if you're married and file jointly.

Filers who are below those thresholds may take the deduction no matter what business they're in, said Jeffrey Levine, a certified public accountant and director of financial planning at BluePrint Wealth Alliance in Garden City, New York.

"Everyone wants to form an LLC. This is a time when an LLC can save you on taxes, but with a caveat."-Sepi Ghiasvand, of counsel, Hopkins & Carley

However, once taxable income exceeds those thresholds, the law places limits on who can take the break. For instance, entrepreneurs with service businesses — including doctors, lawyers and financial advisors — may not be able to take advantage of the deduction if their income is too high.

Finally, partners in a business may also find themselves in a situation in which one owner gets the 20 percent deduction and the other doesn't. That's because a partner with a high-income spouse may wind up exceeding the taxable income threshold.

"What's fascinating is that you can have two people doing the same work for the same pay, but only one can take the deduction on their return because of other factors," said Levine.

Give me a break

The 20 percent deduction is considered a "between the lines" deduction in that it doesn't lower your adjusted gross income and you don't have to itemize on your taxes in order to take it.

Generally, if you qualify for the deduction, the 20 percent break will apply to the lesser of your qualified business income or your taxable income minus capital gains. See below for an example from Levine of BluePrint Wealth Alliance.

Key Facts:

Joint filer with a Schedule C business has a standard deduction of $24,000

Business gross income of $130,000

Business expenses of $30,000

Net profit from business $100,000 (qualified business income)

Spouse works and makes $70,000

Above-the-line deductions of $7,500 for deductible portion of self-employment tax and $20,000 for SEP IRA contribution

Analysis:

Taxable income before application of pass-through deduction = $118,500

In this case, the taxable income of $118,500 is greater than the qualified business income of $100,000. As a result, the 20 percent pass through deduction will apply to the qualified business income, resulting in a $20,000 deduction.

This couple is in the 22 percent tax bracket, so they save about $4,400 in federal taxes.

Limiting your liability

One big advantage in establishing an LLC is the fact that it protects owners from having their personal assets seized by the business's creditors.

Setting up your LLC may cost a couple hundred to a couple thousand dollars, and you'll be required to file your documents with the state in which your business is based.

You will have to tell the IRS how it should tax your business, using Form 8832: Is your business a corporation, a partnership or should it be on your personal tax return?

What you choose matters, and here's why.

Social Security

Entrepreneurs must pay self-employment taxes, which include payments toward Social Security, of 15.3 percent. However, profits that pass through from an S-corp. are subject only to income taxes.

In that case, an owner of an S-corp. would pay the self-employment tax from his salary, instead.

Get into compliance

In order to maintain their liability protection and preferred tax status, owners of S-corps. (and C-corps.) need to have an operating agreement in place, maintain books and records, and track their minutes.

"We've seen plaintiffs' counsel pierce the corporate veil because business owners treat the corporation as a piggy bank and don't maintain bylaws," said Rick Keller, chairman of First Foundation in Irvine, California.

Steady profits

Once your business consistently exceeds $70,000 in annual profits after expenses from 1099 income (as opposed to W-2 wages), it might be time to consider setting up an S-corp., according to Howard Samuels, a CPA and managing partner at Samuels & Associates in Florham Park, New Jersey.

That's because S-corps. are subject to bookkeeping requirements: Owners need to file returns for themselves and the business. They also need payroll services to ensure that taxes are correctly deducted.

Owners should weigh how much they will save on taxes with an S-corp. versus how much they will pay to set it up and maintain it.